Monday, 29 October 2012
Azizonomics claims that when government incurs debt, taxpayers who don’t hold much debt or any debt, pay taxes to fund interest payments to debt holders. (h/t Mike Norman). And that is allegedly a burden on taxpayers.
However that argument omits inflation, which is an important at the moment given that interest on government debt in several countries is more or less equal to inflation in those countries (e.g. U.S. Germany & U.K.).
So let’s run through the argument and let’s assume that interest is exactly equal to inflation (say 2%). If government funds something via borrowing rather than tax, taxpayers who are not in the habit of holding government debt pay less tax. Let’s say to keep things simple that the government debt is repaid (plus interest) after one year. That means that at the end of the year those taxpayers have to fund repayment of capital and interest.
But hang on. $X at the end of the year is worth 2% less than at the beginning. So on balance there is no net burden on taxpayers. In effect, taxpayers just get an interest free loan. Not bad, eh?
Sunday, 28 October 2012
I favour full reserve banking, but I’m not under the illusion suffered by what I think are the more naïve and evangelical full reserve advocates, namely that full reserve will solve every other problem on planet Earth, including environmental problems, poverty, the alleged national debt problem, the alleged personal debt problem.
The national debt.
Full reserve has no bearing on the alleged national debt problem, because that debt is easily reduced at any time. Don’t know how? Try this.
First, have the central bank print money and buy back the debt (exactly what several countries have been doing big time in recent years under the guise of QE).
Second, to the extent that the latter QE type policy is too inflationary, raise taxes (and/or cut public spending) by enough to give a deflationary effect that cancels out the inflationary effect of QE, which frankly isn’t of astronomic proportions. I.e. if the recent and massive amounts of QE have had a huge stimulatory or inflationary effect, where is the evidence? The large numbers of people currently trying to find work would doubtless also like to know.
National debts exist, amongst other reasons, because of a desire by the private sector (pension funds in particular) to hold paper assets. That desire won’t vanish just because we convert from fractional to full reserve.Indeed, there are currently concerns about a SHORTAGE of quality paper assets. Also of some relevance, see David Beckworth’s five facts here.
Put another way, it is the easiest thing in the world for a country that issues its own currency to substantially reduce its national debt. But all that happens is that former debt holders end up holding monetary base. And the latter is also (at least nominally) a debt owed by government to those “holders”. Or put that another way, if a country has a national debt that is of such a size that creditors demand any significant rate of interest, such a country can simply buy back enough of the debt until the interest on that debt nears zero, which makes the debt little different in nature to monetary base.
Now that amounts pretty much to saying that national debts are pointless and that the only liability issued by the government / central bank machine should be MONEY, or monetary base to be exact. And what do you know? That’s exactly what Milton Friedman advocated in a paper entitled “A Monetary and Fiscal Framework for Economic Stability”. He said:
“Under the proposal, government expenditures would be financed entirely by either tax revenues or the creation of money, that is, the issue of non-interest-bearing securities. Government would not issue interest-bearing securities to the public….”
Another authority on these matters, Warren Mosler, said much the same. He said:
“I would cease all issuance of Treasury securities. Instead any deficit spending would accumulate as excess reserve balances at the Fed. No public purpose is served by the issuance of Treasury securities….”
And if you want some more detailed arguments (put by me) as to why national debts are pointless, see here.
Re the idea that fractional reserve increases the amount of personal debt, I largely demolished that idea here. However, a further point needs making in that connection, as follows.
Borrowing and lending takes place for the very simple reason that the cash that households, firms and other entities have at their disposal does not tie up with the cash REQUIREMENTS of those entities. E.g. some people have surplus cash, while others want cash for buying a house. Some people want cash to start up or expand a business, but don’t have the cash to hand.
Now that mismatch between cash available and cash required or wanted is not affected one iota by a switch from fractional to full reserve. Thus a switch to full reserve will not greatly change the total amount of borrowing and lending.
There is however, one route via which full reserve reduces personal debts which is thus.
Assuming the full reserve system implemented is something along the lines advocated by Kotlikoff or Werner, it involves lenders taking a hit where relevant loans go bad (instead of banks or taxpayers taking a hit). And lenders will want extra interest for taking that risk: i.e. interest rates will rise.
The effect of that on its own would be deflationary, thus government would need to create and spend extra monetary base into the economy, which in turn would mean debtors and creditors having a bigger stock of cash. And that in turn would bring a reduced need for borrowing.
So on balance, does full reserve bring instant nirvana for debtors? Hardly. They’d borrow less, but they’d pay more interest on whatever they did borrow. And those two effects might well cancel out. I.e. debtors might continue paying exactly the same total amount of interest. And it’s the affordability of the interest that is one of the main problems for debtors.
The full versus fractional reserve argument is entirely separate from the question as to how to deal with environmental problems. To illustrate, we could perfectly well carry on with the existing fractional reserve banking system and implement substantial annual increases in the price of carbon based fuels starting tomorrow. Plus we could spend twice as much on solar, wind and tidal power generation starting next week. There is nothing about fractional reserve banking that stops us implementing the latter sort of environmental measures.
Tuesday, 23 October 2012
Four articles have appeared recently about whether government debt held by central banks should be torn up. See here, here, here and here. (h/t to Mike Norman). What took those article writers so long? I advocated the idea last Febuary here.
I don’t like saying “told you so”. Well, actually I do.
Told you so.
Monday, 22 October 2012
In this article, Congdon says that bank regulation will constrain bank lending and reduce what he calls “money balances”. I’m afraid that is not the revelation of the century.
To put the point more accurately, more regulation will reduce bank lending and money balances ALL ELSE EQUAL. And therein lies the flaw in his point. I.e., all else does need to be equal.
That is, if regulators decide that the amount that loss absorbing bank creditors have to stump up per pound or dollar of bank lending / investment should be doubled, then clearly that has a deflationary effect. But that’s easily countered by having government and central bank create and spend more money into the economy.
The effect of that is to increase the cash balances of every household and firm, thus the latter WON’T NEED to borrow so much. To that extent, reduced bank lending doesn’t matter.
Congdon then says, “Further, the more zealous regulators are in eliminating risk from bank balance sheets, the more rapid is the destruction of money balances.” Well poor old Tim must be having fits at the full reserve proposals put by Laurence Kotlokoff, Positive Money, Prof. Richard Werner and others. Reason is that the latter proposals pretty much remove ALL RISK from bank balance sheets (the risk is loaded onto depositors who want to behave in a commercial fashion: i.e. have their money invested).
Now personally I don’t see much wrong with removing risk from bank balance sheets: risk which is actually born by the taxpayer. And that risk taking amounts to a HUGE SUBSIDY of the banking industry. Personally I think there is NO EXCUSE WHATEVER for subsidising an industry which ought to pay its own way. But if Congdon has good justifications for that subsidy, I’m all ears. I’ve read several of his publications and don’t remember him justifying mega bank subsidies, but I might have missed something.
Sunday, 21 October 2012
The conventional and economically illiterate story about the deficit (repeated a thousand times by politicians and other ignoramuses) is as follows (in green).
There’s a deficit. We could reduce it by raising taxes or cutting public spending. But that hits growth: the last thing we want in a recession.
On the other hand if the deficit continues, that can lead to too large a national debt, which in turn means creditors may ask for higher rates of interest. Now we’re really in a bind, aren’t we?
Answer: “no, we’re not.”
The above nonsense was unfortunately repeated recently by “Economics Help”, an economics tutorial site (which publishes informative material 99% of the time).
The truth about deficits and debts.
The following explanation is actually just an expanded version of one of the most succinct phrases ever uttered by an economist: it was Keynes’s phrase, “Look after unemployment, and the budget will look after itself”. But the meaning of that phrase is way beyond the comprehension of the above ignoramuses, which is why it is necessary to explain the phrase (over and over and over again).
First, deficits do not need to accumulate as extra debt. As Keynes, Milton Friedman and a hundred other economists have pointed out ad nausiam, deficits can equally well accumulate as extra monetary base. Unfortunately the above Economics Help article gets this point wrong: its opening paragraph reads, “A budget deficit occurs when a government spending is much greater than tax revenues. This leads to an accumulation of public sector debt.”
Indeed, thanks to QE, recent deficits ACTUALLY HAVE accumulated to a large extent as extra base rather than debt. Doh!
Second, EXPANDING NATIONAL DEBTS WILL NOT LEAD TO ELEVATED RATES OF INTEREST AS LONG AS DEBT HOLDERS ARE HAPPY TO HOLD THE EXTRA DEBT.
Indeed, that’s exactly what has happened over the last two or three years (Doh again).
Moreover, the very fact that debt holders are happy to expand their debt or monetary base holdings is proof that the private sector’s desire to save money rather than spend is contributing to unemployment: it’s proof that Keynsian paradox of thrift is at play. I.e. as long as interest rates remain low, running a deficit with a consequent rise in the debt or base is EXACTLY THE RIGHT POLICY.
Rising interest rates.
In contrast, if the rate of interest demanded by creditors DOES RISE, that is proof that creditors are NOT SO WILLING to hold or expand their holdings of debt or base (forgive the statement of the obvious, but this article is very much into stating the blindly obvious).
Given rising interest rates, a country will not, REPEAT NOT, have to pay any additional interest immediately: it will only pay additional interest (if it’s silly enough to actually do so) on NEW DEBT or “rolled over” debt.
But the rational reaction in that scenario is to just abstain from issuing new debt. I.e. the rational policy is to pay back creditors EITHER BY by getting the money from raised taxes (and/or public spending cuts), OR BY printing money and paying off the creditors.
As to which of the latter two to go for, that depends on whether the economy can take more stimulus or not. If it can, then the money printing option is best. If not, the raised taxes / public spending cut option is best.
And the reaction of the ignoramouses to the above two options is a predictable as it is boring. They react to the money printing option with the word “inflation”. Well there won’t be any inflation if the economy still has significant unused capacity (exactly what has happened over the last two or three years - doh again).
And as the idea that those tax increases or spending cuts will hit growth, they’ll have absolutely no effect on growth in the sense that if inflation is allowed to run riot, far from bringing increased growth, it just brings chaos and REDUCED GROWTH.
In other words (irony of ironies), given rising inflation, confiscating household’s money via tax (or implementing public spending cuts) actually make everyone better off, or at least it prevents them becoming WORSE OFF as a result of the damaging effects of excess inflation.
To summarise, for a country that issues its own currency, the best policies are:
1. Given a large deficit and rising national debt and excess unemployment the correct response is to continue with the deficit and rising national debt (though letting the deficit accumulate as extra base would do equally well).
2. Given excess unemployment and rising interest rates the correct response is to continue with deficit but let it accumulate as extra base.
3. If the latter looks like exacerbating inflation, then unemployment is not excessive – at least in the sense that there is some level of unemployment below which it is difficult to go without inflation kicking in. And if inflation IS RISING, that point has probably been reached. Dealing with the remaining unemployment is then difficult: at least, the problem cannot be solved by the simple expedient of increasing aggregate demand.
Sites that broadcast a similar message to the above:
Or if you like videos (h/t to Mike Norman):